Following J.P. Morgan Chase’s JP MORGAN CHASE & CO.
better-than-expected earnings Wednesday, the stock market rallied — led by financial stocks and big banks whose shares are up nearly 17% since mid February, when oil prices began to rebound.
Come Thursday, though, that tune changed.
Bank of America BANK OF AMERICA CORP.
Though BofA says its credit quality remains strong, the company’s total provisions for bad loans are up from $525 million to $1 billion due in part to potential losses on loans it has made to energy companies.
Hours later, Wells Fargo WELLS FARGO & COMPANY
reported a 6% drop in its profits. In a statement Thursday, Wells’ chief risk officer Mike Loughlin noted that the bank’s “oil and gas portfolio remains under significant stress due to low (oil) prices and excess leverage in this industry.”
While the results weren’t particularly surprising, analysts are worried that things might get worse still, spreading fear beyond the financial sector to the broad stock market.
Why all the gloom and doom when oil prices have rebounded more than 50% since late January?
Despite the recent bounce back, crude prices are still down more than 60% from their 2012 highs and off more than 70% from their pre-financial crisis levels.
The recent recovery has soothed nerves on Wall Street for now, but prices will have to rebound substantially more for many small- and mid-sized oil companies to fully recover.
Until that happens, investors are keeping their eyes on banks with major oil and energy sector exposure.
Wells, JP Morgan, and Bank of America have set aside $4 billion to cover losses brought on by oil’s multi-year slump. While that’s peanuts compared to the banks’ total assets, it’s enough to worry the Street.
The big question: Is there any relief in sight for these lenders? A lot of it comes down to whether OPEC will cut production and plug the global crude oil supply glut sooner rather than later, which would help lift prices.
Around two dozen leading energy-producing countries, including OPEC member nations as well as Russia and Mexico, are expected to meet this Sunday in Doha, Qatar to discuss possible production curbs.
“Without an OPEC cut, 2016 prices will probably be in the $30 per barrel range,” according to a February report by Arthur Berman, a consultant at Petroleum Geologist Labyrinth Consulting Services. “Widespread defaults and bankruptcies are possible in the first half of 2016,” he continued.
If credit quality continues to deteriorate and revenues plunge further, “this is going to be a very tough year,” according to analysts at IHS.
As more energy companies file bankruptcy, banks will have to tap into their reserves. If the price of oil continues to drop, or even stays below $50, that’ll be increasingly likely, according to Paul O’Donnell at IHS.
In the meantime, the credit-rating agency Moody’s has downgraded more than 100 energy companies since December. (North American oil and gas companies owe $27 billion in debt.)
It’s still too soon to panic. That same Moody’s report noted that the impact of bank losses from the energy sector will be spread out over more than a year, and the charges should be cushioned by rising earnings from other endeavors.
Still, it’s a sign that oil and banks — and the broad stock market for that matter — aren’t out of the woods just yet.